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When the solution becomes a problem...

Economic outlook

The global ‘splint’ of QE will continue to be used to hold up asset prices, as central banks dare not lift the tide of liquidity hiding the sharp rocks beneath. The risk for pension funds, though, is that ‘looser for longer’ may have many years left to run.

As a result of their asset purchases, the world’s big four central banks‘ balance sheets have in total ballooned to over $13trn. This liquidity injection to the private sector is equivalent to about three quarters of US GDP, or 1¼ times China’s.

This means one half of the world’s total central bank assets has been amassed in just seven years - that is, after the last US recession ended in mid 2009. QE has since been a less than perfect remedy, & in the faster-growing US & UK has probably had its day.

Early QE can be credited with unclogging the financial system in 2009, providing liquidity, keeping bond yields down, & yield curves steep. It also loosened the reins further when rates were on the floor. When we factor it in, the US & UK are running negative rates.

As we know from Japan, the main benefit is to keep yields down for even longer. Yet, by distorting financial markets, suppressing saving, & increasing the funding strains on many pension schemes, QE may be fast becoming a problem not the solution.

With central banks the biggest sponsor of bonds, private institutions may increasingly struggle to find the bonds they need. It’s doubtful they can step away without unintended consequences. Their own ‘skin in the game’ also makes this unlikely.

So, central banks seem hell-bent on QE. With Japan still accelerating it after 17 years, most investors have never experienced a central bank turn it off. The last time the US Fed did QE proper was to pull its economy out of the 1930s depression.

Then, it ran QE unbroken for 14 years up to 1951 - despite double-digit inflation touching 20% in 1947. Clearly this was a different time. But, if it’s in any way a guide, we could say we are today only about half way through our QE!...

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Neil WilliamsGroup Chief EconomistNeil joined Hermes in August 2009 and is responsible for Hermes’ economic research. He has a forward-looking approach to generate investment strategy ideas. Neil adopts top-down methods – macro and market analysis to identify interest rate and credit value, and sovereign default risk. Neil began his career in 1987 at the Confederation of British Industry (CBI), becoming its youngest ever Head of Economic Policy. He went on to hold a number of senior positions in investment banks - including Director of Bond Research at UBS, Head of Research at Sumitomo International, Global Head of Emerging Markets Research at PaineWebber International, and, before coming to Hermes, Head of Sovereign Research and Strategy at Mizuho International. Neil has 29 years’ industry experience and earned an MA in Economics in 1986 from Manchester University, having the previous year completed his BSc (Hons), also in Economics, from University College Swansea. Read all articles
by Neil Williams